Delay and new cost conditions may persuade De Beers to abandon the Grib pipe

By John Helmer in Moscow

Unclear conditions set for De Beers’ s new Archangelsk region diamond project, and unexplained delays by the Russian government in communicating them, are likely to trigger the cancellation of the $172 million fund-raising, held last June by Archangel Diamond Corporation (ADC). The money to finance the restart of the big diamond mining project has been held in escrow since the placement was closed on June 24. It is now likely to be returned to its contributors, who have seen the value of their shareholding in ADC fall by 60% since June.

On October 10, Russia’s Control Commission for Foreign Investment, a cabinet-level body chaired by Prime Minister Vladimir Putin, reviewed the application by De Beers and LUKoil for state approval of its joint venture to mine the Grib diamond pipe, with an estimated $7 billion in mineable diamonds. A public announcement of the approval was issued to the press by a member of the commission, Igor Artemyev; he heads the Federal Antimonopoly Service (FAS), which is the staffing agency for the commission.

The commission should have produced a signed protocol of its ruling, and sent it to De Beers and LUKoil within three days of signing. But ADC has not announced this receipt yet. FAS sources were unable to say on October 20 whether the protocol has been signed. According to the commission regulations, once the signed notice of decision has been sent to the applicants, they have 20 days to confirm their acceptance.
In this case, however, Artemyev announced that commission approval is conditional on acceptance of a beneficiation scheme. This will oblige the project developers to invest in cutting and polishing the diamonds to be mined from the Grib pipe. FAS declines to say what proportion of the Grib output should be cut and polished in Russia; or to clarify whether the condition requires the establishment of a new manufacturing plant in the region. It is also unclear whether the commission condition is an obligation for ADC alone, or for LUKoil’s project subsidiary, Arkhangelskgeoldobycha (AGD).

DeBeers and ADC ought not to have been surprised by the beneficiation condition, because this has been public policy in Russia for several years now for new mining projects. It was attached as a condition of the most recent major state mining project, the Udokan copper concession, which was awarded in September. Comparable beneficiation conditions have been attached to De Beers diamond mining projects in Canada, Namibia, Botswana, and South Africa. However, until the control commission and FAS clarify the issue, it is not known whether the Arkhangelsk project will require 100% of the mine output to be cut and polished locally, or elsewhere in Russia. In the other countries, beneficiation generally covers between 10% and 30% of the mined rough.

According to the ADC press release, the company is “continuing its efforts to obtain information from FAS in regard to its application for approval of the Transaction under the Russian law on protection of competition, the final condition precedent to the Transaction.”

ADC, the Toronto listed diamond miner funded and controlled by De Beers, has issued a detailed summary of the terms of the agreement with LUKoil, which Nicky Oppenheimer signed in Moscow in mid-April. The price DeBeers and ADC have agreed to pay is divided into three tranches — $100 million in down-payment, when and if the transaction closes; $75 million when LUKoil and ADC agree to go ahead with the construction of a diamond mine at the Grib Pipe and AGD gives its accord to mine; and $50 million when commercial diamond production starts. It is estimated by the Russians that the mine go-ahead is unlikely before 2011; and commercial production by 2015.

The agreement with LUKoil provides that De Beers will hold a 49.99% stake, and LUKoil will hold the rest. De Beers will act as technical consultant to the project, retained by the project operator, AGD, the LUKoil owned geological company and license holder. The payment and equity arrangements indicate a total valuation of the asset at present at $450.1 million.

However, shareholders of ADC appear to want their cash back for the initial financing of the first $100 million tranche of the deal. According to ADC press releases, a private placement with DeBeers, Firebird, and other shareholders in June of this year raised $172 million at an attributable price of US$1.25 per single ADC share. During the month of June, that share price moved between $1.40 and $1.15. It is now down to 50 cents. At this level, the subscribers to the placement would be financially better off getting their money back.

According to the terms of the placement, disclosed publicly by ADC in June, the fund-raising would deposit the $172 million in escrow until a deadline of October 17 to allow time for all transaction approvals to be issued by the Russian government. Because the control commission had not completed its qualified approval, and ADC had not signed its acceptance by the deadline of last week, the placement may now be returned to its subscribers. Once that occurs, De Beers will be obliged by its earlier guarantee to provide $115 million to ADC to finance the project start-up. However, if De Beers is facing a substantial bill for new domestic cutting and polishing works, it may decide to opt out of the deal entirely.